Our View in September

Published:27 September 2023 17:06 CET
Analyst:
Nadiia D, Content Manager, nadiia.d@adviscent.com

China and Europe are landing on the hard ground of reality, while the US economy continues to defy gravity. This is also evident in stock markets.

German Chancellor Olaf Scholz felt compelled to declare a national effort, a "Pact for Germany", to modernise the country and to do something against the economic weakness. Because everywhere you look, the economic mood is bad. Add to that the slump in construction and falling property prices. The picture in China is not much different, with perhaps one exception: Chinese carmakers seem to grab market share from competitors from Germany, among others, when it comes to electric vehicles.

The situation in the US is quite different. According to estimates by the Atlanta Fed, the economy is heading for an annualised growth of 6 % in the third quarter. So the recession is still a long way off. And from the market's point of view, it is slowly but surely losing its horror. At least that is what the US stock market suggests, which has performed much better in recent months than its counterparts in Europe and China.

Different worlds, then. But not necessarily independent of each other. Certainly, the resilience of the US economy is good for the rest of the world. We take this into account by reducing the underweight in equities somewhat.

However, the US will not be able to decouple from the rest of the world in the long run. In addition, the recent rise in yields in the US dollar has shown that good or better economic news is not necessarily good for the markets. Therefore, we remain cautious.

Portfolio

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Strong Overweight
Neutral
Strong Underweight
Opportunities
  • Central banks likely to raise interest rates only slightly from here on
  • Economic risks have diminished somewhat
  • Market breadth has increased
Threats
  • High valuations for US technology stocks
  • Inflation still above Fed and ECB targets
  • Economic weakness in Europe and China
Economy
Economy Overview

Less steam in the US labour market

First cracks in the US labour market are now visible. US consumers indicate in monthly surveys that there are not quite as many jobs available as there were a few months ago. This is matched by the declining number of job openings. Once cracks appear in the labour market, the economic picture darkens in the following quarters. A look at historical pattern reveals this. We are therefore sticking to our US recession scenario, even though the US economy is likely to grow strongly in the current quarter. Meanwhile, the eurozone is weakening. The construction industry in particular has been hit hard. As this is an industry with significant multiplier effects - both positive and negative - the euro area economy is likely to remain depressed in the second half of the year.

Opportunities
  • In the US, the recession is delayed even further
  • We expect strong growth in the US in the third quarter
Threats
  • Economy in the eurozone remains depressed
  • Difficult global economic situation
  • Leading indicators point to a weakness in the services sector
Monetary Policy
Monetary Policy Overview

ECB policy remains exciting

While the Fed has reached its interest rate peak in this cycle, the interest rate policy of the European Central Bank (ECB) remains fraught with question marks. In France, for example, the inflation rate rose noticeably in August. The harmonised rate went from 5.1% to 5.7%. In Spain, too, inflation accelerated again. In Germany, the decline was only minimal. At the same time, the euro area economy is struggling, which is why many economists conclude that the ECB has already reached its interest rate peak. However, the central bank has a clear mandate to fight inflation. Therefore, there is no alternative to an interest rate hike in September. It should also be borne in mind that inflation rates are still far above the key interest rate. Thus, the European monetary policymakers are by no means restrictive and so another rate hike should be on the agenda in September.

Opportunities
  • The Fed has reached the interest rate peak
  • The SNB back in the realm of positive real interest rates thanks to low inflation rate
Threats
  • The ECB is in a dilemma due to the weak economic development
  • Restrictive monetary policy increases the potential for financial market stress
Bonds High Grade
Bonds High Grade Overview

Higher for longer?

Long-dated US yields rose to a new high in the current Fed rate hike cycle. They experienced a short-lived rise of almost 60 basis points since mid-July. The reason often given was that the prospect of a prolonged phase of higher key interest rates drove yields up (higher for longer). However, in recent weeks interest rate expectations have not shifted backwards as significantly as would justify a rise in yields of almost 60 basis points. In our view, the US economy serves as a much better reason, since it is turning out to be more robust than previously thought. Recession risks are shifting further back, which in turn increases short-term inflation risks. However, since we still expect a recession, it should only be a matter of time before interest rates at the long end of the yield curve fall noticeably.

Opportunities
  • As long as there are recession risks, yields at the long end of the yield curve will not rise significantly
  • We see record forward sales of US Treasuries as a contra-indicator pointing towards falling yields
Threats
  • Inflation rates in the euro zone remain far above the ECB target, which could force a continued tightening 
  • Creditworthiness may come to the forefront of investors' minds
Bonds Investment Grade
Bonds Investment Grade Overview

First a soft landing, then a hard one?

Corporate bonds have performed slightly better than government bonds so far this year. In USD, the performance is 1.7% compared to -0.2% for government bonds. In Europe, too, the performance difference stands at around 2%. The reason is the recent rise in risk-free rates while credit spreads declined slightly. This is untypical for an interest rate hike cycle. Normally, an aggressive path of rate hikes leads to a recession and thus to falling risk-free rates but rising credit spreads. We still see this scenario playing out. Currently, the one-year Treasury bill yields 5.4%, while corporate bonds with an average duration of seven years yield 5.75 %. Even if the soft landing scenario lasts longer, the compensation for risk is extremely low. If the soft landing would be  followed by a hard landing, double-digit losses are likely. We therefore prefer government bonds.

Opportunities
  • US economy still quite robust
  • Companies have made use of low rates and are feeling the rising interest rate with a delay
  • Real yield at 15-year high
Threats
  • Extremely modest compensation for risks taken
  • Economic risks not yet off the table
  • Inflation likely to rise in coming months due to base effects
Equities
Equities Overview

Choppy seas for equities worldwide

While the equity markets should have been occupied by earnings, it was the rise of yields that dominated again in August. The weakening economies in China and Europe also left their mark. So although on average the very low profit expectations were exceeded, some companies were negatively affected. They are increasingly feeling the effects of consumer restraint. However, the sharp rise in yield in August was the main reason for declining equity indices. Some economic indicators and comments by central bankers were the reason for that move. However, towards the end of the month, the signs were again pointing to a recession, which triggered hopes of interest rate cuts. A recession would indeed lead to falling prices. But if it were to occur only next year, we could see a year-end rally.

Opportunities
  • End of interest rate hikes approaching or possibly already reached
  • Better half-year results than expected
Threats
  • Equities not signalling recession, though leading indicators suggest this is happening
  • China's sluggish economy affects European stocks
  • The end of the interest rate cycle may have been anticipated
Equities US
Equities US Overview

Interest rates matter again

While other markets are also reacting to higher interest rates, the movement in the US has been very sharp. This is mainly due to the fact that the majority of the performance in the current year can be explained by a few interest rate-sensitive technology stocks as well as increased valuations. Weaker labour market data in particular should fuel hopes of an end of the rate hike cycle, although such weaker data are just another indication of a possible recession. Markets could therefore rise again for the time being. This is because technical indicators are currently in the proverbial no-man's land and leave the chances of price gains. However, the development should be viewed with caution, as in addition to the weaker services PMI, comments from consumer companies also point to weak consumer spending. This could lead to a recession and a correction.

Opportunities
  • Increasing optimism for third quarter results
  • End of interest rate hikes could have a positive impact
Threats
  • Service PMIs are also weakening
  • Valuations above average of the last 5 and 10 years despite higher interest rates
  • Unattractive expected earnings yield versus lower-risk bonds
Commodities
Commodities Overview

New risks in energy markets

Winter is upon us. Just a year ago, there was great concern that an energy crisis in Europe was inevitable. Today, the situation seems to be relaxed, at least on paper, as stocks have already reached last year's highs. But appearances are deceptive because the risk landscape has changed significantly, as was made evident by the threat of strikes in liquefied natural gas plants in Australia. As Europe made up for lost volumes from Russia with imports of liquefied natural gas (LNG), capacity flexibility has been lost and competition has increased. It is also controversial that 15% of EU gas imports still come from Russia. This raises the question whether the EU wants to change this. For energy prices, this means that even small distortions on the supply or demand side can lead to price turbulence.

Opportunities
  • Increased liquefied gas imports reduce Europe's flexibility
  • Russia still responsible for 15% of gas imports
  • Longer cold spell could increase demand
Threats
  • Europe's gas inventories are well stocked
  • Weaker economy would reduce demand
  • Coal and oil products could absorb part of impending supply shortage
Cash
Cash Overview

Euro appreciation comes to a standstill

There have been no significant movements in the EUR/USD currency pair recently. At the moment, a certain comfort zone seems to have been reached at levels between 1.08 and 1.09. This is mainly due to the fact that the ECB's interest rate policy comes with some question marks. Should the European monetary policymakers signal that the interest rate peak has been reached, the appreciation potential of the euro would probably be limited in the coming months. Europe's common currency would thus lack buying arguments, especially since the economy is doing much worse than in the US. Meanwhile, the franc remains firm, supported also by foreign exchange market interventions by the Swiss National Bank (SNB). The latter reduced its foreign exchange holdings by almost CHF 300 billion in the past quarters.

Opportunities
  • The franc remains well supported also thanks to foreign exchange market interventions by the SNB
  • The British pound benefits from higher key interest rates and the shrinking interest rate differential to the Fed
Threats
  • Due to the uncertain interest rate path of the ECB, there was no further euro appreciation
  • The Turkish lira remains under the spell of politics